As serious contract negotiations get underway in Hollywood this year (the WGA is up first, to be followed by S.A.G. next year) there is no better place to spend some time than reviewing the excellent work of Edward Jay Epstein here: hollywood economist

As Epstein makes clear, the deck is stacked against all but a handful of superstars in Hollywood. Why? In part, of course, it is because of the sure thing marketability of certain stars like Tom and Arnold and Julia. That is certainly how the studio bosses see the issue. And there is a certain amount of truth to that. Of course, while those stars may be expensive it is also less costly to produce movies around a small number of bankable names. But that opens up a different can of worms.

The point I want to make today is to focus on the key formula in modern Hollywood economics: the 80/20 split. Where does that come from? Well, as Epstein makes clear, the 80 percent is taken off the top by the distribution arms of the large studios. The 20 percent is what they leave on the table for producers, actors, writers, directors and crew to fight over. Unless, of course, you are Tom, Arnold or Julia and rep’d by Ari Emanuel and Bert Fields – well, then you might be able to break into first dollar gross for a piece of that 80%.

(Of course, this is a partial simplification of a very complex legal and financial structure. An experienced entertainment lawyer together with the film industry accountant who rep’d Art Buchwald has posted a useful summary with greater detail for those who might be interested: Less than zero)

Now, how did the Hollywood bosses accomplish such a feat? No other employer in America has such a sweet deal. Not even in other talent centered businesses like professional sports – while I have criticized the huge salary paid to the football players head Gene Upshaw and am very concerned that the football players of today are doing too little too late to help the pioneers of the game – there is no arguing with the deal they have cut with the league – something like 60% of the revenues earned by football are shared among all the current players.

But in Hollywood it is far different.

The secret to unraveling this is to understand the fork in the road taken by the industry in the 1970s and 1980s. What seemed like an inconsequential decision then has now, with the advent of new technology and finance, morphed into a monstrous inequity in power and money. And unless the guilds tackle this head on – 80/20 or bust – then the danger is that this round of bargaining will lock talent into second class citizenship for another generation.

Yes, folks, imho, the upcoming round of contract talks is that important.

But back to the story: distribution is now where the action is and that is currently in the firm grip of management – a grip as tight as that of Charlton Heston around that rifle! When the VCR came along 25 years ago, the studios thought it was an uncertain arm of their operations and were willing to just accept a 20% royalty – a kind of standard when a new technology emerges – from the then-independent distribution companies. As one retired film exec explained to me recently, “we were just happy to get anything at all out of after market sales of videotapes.”

But when the DVD came along that changed dramatically – DVD sales became the most important profit center in the film business and studios took the formerly independent distribution companies in house! Now that 80% was going to them but they continued to pay their “production” arms the old 20% rate!

As Epstein puts it:

“studios sought to increase their leverage, or throw weight, by buying up independent distributors (and later ‘mini-majors’) to get more titles. As a result, six companies Time Warner, Sony, Fox, Viacom, Disney and Universal – came to dominate not only all the major releases but the entire universe of so-called indie releases.”

So as billions of dollars started flowing into studio coffers in the late ’90s and early ’00s there was a ring fence around that money, leaving only one dollar out of five available for formal collective bargaining and contract negotiations for most talent. And yet it is the talent that makes distribution so profitable! Without the quality and hard work of creative and skilled workers there would be nothing to distribute.

Fast forward to 2007 and now things get really interesting: two forces are converging on the industry – new forms of finance and a literal revolution in distribution itself. The DVD gravy train is still huge but like any technology it is reaching maturity. A company like Netflix has been able to squeeze some more profit out of the distribution side but growth has slowed considerably. While new formats like BluRay may help, the truth is that online distribution in some combination with landline, cable or satellite technology is the future. This will mean on demand film distribution to a range of available platforms. For the latest example, see this article on a new Silicon Valley company that appeared in the NY Times yesterday: Vudu casts its spell on Hollywood.

Some people may think that watching a movie on an iPod makes no sense – and sure if you want the full effect of a great score or of visual effects nothing replaces a great theatrical experience, but try sitting in an airplane for seven hours with only the on board film to watch (over and over and over). That iPod – particularly when the quality is as good as it can get these days – comes in handy.

So billions of dollars are now flowing into three key channels: telecommunications companies (broadly defined to include cable, landline, satellite), digital delivery devices (iPhone, etc.) and content creation. Hedge funds, venture funds and private equity funds are the key channels through which the money is flowing to seek out the winners in these sectors. (Public markets like the NYSE and Nasdaq are far too clumsy for this process – a story I leave for another day – but check out my latest paper on the NYSE if you are interested in some of the arguments: Ringing the Bell on the NYSE)

Back in Hollywood, the game is simple – keep that 80% off the table no matter how big it gets. And this is where, of course, the ongoing negotiations between the S.A.G. and the talent agents come in. The agency business is changing rapidly. The lead agencies know the big money is in distribution. By breaking away from the agreement with the Guild, the agents are now free to try to get in on that big money through production deals. And they can now offer some small layer of talent the opportunity to participate. In other words, the breakaway agencies try to lure talent away from a collective (i.e., union) approach to solving the problems of the industry into an individual deal making approach.

And for the vast majority that way lies disaster. Only a tiny number of stars will have any real chance of breaking into the 80% through individual bargaining. It is only by bargaining collectively that there is any hope for the working actor (and crew, and writers, producers and directors!) In fact, for all but a handful of agents the same thing applies to the agents (and managers and lawyers and accountants that represent talent). In other words, this round of contract negotiations must become a collective effort to restructure the 80/20 rule for the benefit of the vast majority of the industry. If the guilds accept the gambit of the producers (to postpone the whole problem) or go the route taken in Canada recently (where a much smaller union agreed to only incremental increases in their share of the 20%) they risk setting a formula in place as damaging as the original 80/20 deal made more than two decades ago.

Given the monumental technological, financial and organizational changes underway in the industry it makes sense to define “good faith” bargaining today to mean an obligation to place the entire financial structure of the industry on the table, out in the open, for all parties to see, to understand and to negotiate over.

Doomsday scenarios are proliferating as the Dow and global debt levels increase to what seem to be unsustainable levels.

Of course, it is important to keep in mind that much of the growth in debt
levels is paralleled by a decline in the outstanding amount of equity – buyout groups like
Blackstone and KKR create debt in partnership with banks to buy up the
outstanding shares of a publicly traded company. This is sometimes referred to as
de-equitization.

The process is compounded by the attempt of existing publicly traded companies
to match the returns of PE firms by leveraging up their own companies through
borrowing to repurchase their own stock. This has now gone so far as to see in some
companies an effort to create debt instruments tied to the returns of particular assets
within the company rather than the company as a whole.

Debt trades in a slightly more disciplined manner than stock, generally
speaking, and, of course, for the debtor company it comes with many more strings attached. It is
fair to say that it is a form of ratcheting up the pressure to increase profitability.

At Delphi, for example, the Board of Directors borrowed 5 billion dollars and
then declared bankruptcy thus wiping out the common stock and putting complete control of the
company into the hands of bankers, the buyout czar Steve Miller (a close
associate of vulture capitalist Wilbur Ross) and the board of directors.

I believe this leverage up/equity down aspect of the cycles of fictitious
capital needs to be better understood before one could confidently claim we are in a bubble about to
burst.

I have become increasingly interested in the futility of regulating capitalism. Of course, this is considered heresy for those on the broad left so many of whom pin their hopes on this or that politician as the savior of labor or of a socially responsible capitalism. But as this essay from an articulate conservative suggests, the word corruption does not begin to describe the cozy relationships between powerful rentseeking corporate interests and the government. I was particularly intrigued by his comments on private equity – noting how depenendent the success of these firms is on government connections.

Enronization

A superb summary of why China remains an authoritarian capitalist society. I have predicted that China is likely to face a major crisis in the next five years, most likely after the 2008 Olympics, either because of social unrest led by disgruntled workers and peasants, or because of a financial collapse due to its mismanagement of the process of economic restructuring.

Beijing’s Dilemma – WSJ.com

I noted here recently that US labor unions seemed slow to take on private equity’s push to restructure corporate America. But as soon as I had uttered those words came this story indicating a toe in the waters by SEIU. The NY Times reports on a new website they have set up tracking the activities of US private equity giant Blackstone Group which is gearing up for an IPO. Frankly, the SEIU site looks pretty tame. Far more interesting is the site set up by Peter Rossman of the International Union of Foodworkers in Europe. Its URL is: IUF Website on Private Equity

A Union Takes Cautious Aim at Blackstone’s Public Offering Plan – New York Times

It has not gotten much attention here, but a battle royal is brewing across the pond over private equity. A major effort to rein in buyouts is being led by the European labor movement. A series of private conferences over the last year or so laid the groundwork, with the International Union of Foodworkers leading the way. This article from the London Guardian describes the core issues.

Private equity boss and union in landmark meeting | | Guardian Unlimited Business

Meanwhile back in the USA, it was recently reported that a very sizeable portion of the funds raised by private equity funds come from public sector pension funds that, ironically, are often jointly managed by union representatives, as in the case of the giant CalPERS where a union official has been president for several years running now.

The London Financial Times published my letter today that takes issue with their attack on a lawsuit against Wall Street investment banks. The plaintiffs are suing those banks for their manipulation of the IPO process during the technolgoy bubble of the late 90s.

FT.com / Comment & analysis / Letters – Citizen investors deserve protection

It has to say something about the global labor environment that Chinese workers are better off striking in Romania than they would be in China itself. Can you imagine what would happen to the same workers in China itself? Thousands there have been arrested, harassed and jailed for leading a massive protest over the last few years again unemployment and inequality. One can only imagine what would happen if Romanian workers working in China tried to strike.

english.eastday.com

Generally, I detest the idea that so-called “big labor” is a bloated overpaid bureaucracy. Usually those attacks come from places like the Wall Street Journal’s opinion page. But just what have the football players been getting that is worth paying their union head $3 million a year?? Especially in light of the tragic plight of many retired players decribed here by the New York Times and last week by Yahoo Sports. Could finding a way to cover health insurance and a minimal pension for these players be so difficult for today’s union leadership to accomplish? Last year, Congress held hearings into the way the Players Union operates and that is likely to continue this year. Every union has an obligation to help those who worked so hard to establish what current members enjoy. The Mine Workers did so when black lung struck an older generation and the Auto Workers are attempting to do the same with retiree benefits (though with only moderate success). Where the pay gap between one generation and the next is so large, today’s generation has a responsibility to “do the right thing.”

Ex-Players Say Increase in Pensions Is Needed – New York Times

Ever wonder what it would be like to predict the future? Sometimes a hard look at the past is the best way to predict the future.

Workers in Hollywood – actors, writers, directors, and craft workers – have just such an opportunity today. Down one road is that laid out by Nick Counter in his propaganda campaign over the last couple of years. Every time he says the same thing about the internet and digital delivery: “Who knows?” and since we don’t know, we can’t pay. Down the second road, those in Hollywood who develop and create the content that then is distributed globally share equally and fairly in the revenues generated by this new business model.

How can we know that there are two possible roads? Because in many ways the tragic plight of today’s aging NFL stars – described so well in this piece from Yahoo Sports – indicates what happens when a weak union is unable (and apparently still unwilling) to counter the “Who knows?” argument from employers. In the 1960s the early Super Bowls could barely fill up the LA Coliseum! Now the Super Bowl makes the league, broadcasters and advertisers hundreds of millions (an estimated 379 million this year). But that is no consolation to the players of the 60s and 70s who were unable to get their fare share of the value they helped create.

A steep price to pay – NFL – Yahoo! Sports